The business sells services or goods for money and in the process the business also have to buy services or goods to be able to sell their services or goods. These business activities can briefly be illustrated in the following diagram:

 

 The above diagram clearly illustrates the transactions that occur frequently in a business. There are also a number of parties involved. The affect of these basic transactions on the accounting equation can be illustrated as follows:

The owner invests in the business:

  1. Owner invests cash:

    The business receives the cash from the owner and that the business owes this amount to the owner, which is the owners interest in the business.

    +

    Assets

    =

    +

    Capital

    Debit - Bank Account = Credit - Capital Account

  2. Owner invests assets:

The business receives an asset e.g. a motor vehicle from the owner and it increases the business assets. On the other hand it also increases the owners interest in the business.

+

Assets

=

+

Capital

Debit - Vehicles Account = Credit - Capital Account

Purchase of assets:

  1. Purchase of assets and pay cash:

    The business receives an asset e.g. a motor vehicle, stock; etc. from another party (the supplier) and it increases the business assets. On the other hand it also decreases the assets (cash in the bank).

    +

    Assets

    =

    -

    Assets

    Debit - Vehicles, Stock, etc. Account = Credit - Bank Account

  2. Purchase assets on credit:

The business receives an asset e.g. a motor vehicle, etc. from another party (the supplier) and it increases the business assets. On the other hand it also increases the liabilities towards the supplier, which will then be referred to as the creditor.

+

Assets

=

+

Liabilities

Debit - Vehicles, Stock, etc. Account = Credit - Creditor’s Account

Incur expenses:

  1. Incur expenses and pay cash:

    The business receives the value of goods and services, which the business will consume or use up in the normal business activities, e.g. placing of an advertisement, fuel for the motor vehicle, etc. and it increases the business nominal accounts, the expense accounts. On the other hand it also decreases the assets (cash in the bank).

    +

    Expenses

    =

    -

    Assets

    Debit - Advertisements, Fuel, etc. Account = Credit - Bank Account

  2. Incur expenses on credit:

The business receives the value of goods and services, which the business will consume or use up in the normal business activities, e.g. placing of an advertisement, fuel for the motor vehicle, etc. and it increases the business nominal accounts, the expense accounts. On the other hand it also increases the liabilities towards the supplier, which will then be referred to as the creditor.

+

Expenses

=

+

Liabilities

Debit - Advertisements, Fuel, etc. Account = Credit - Creditor’s Account

Purchase of stock or goods for resale:

  1. Purchase of stock or goods and pay cash:

    The business receives an asset (stock) from another party (the supplier) and it increases the business assets. On the other hand it also decreases the assets (cash in the bank).

    +

    Assets

    =

    -

    Assets

    Debit - Stock Account = Credit - Bank Account

  2. Purchase of stock or goods on credit:

The business receives an asset (stock) from another party (the supplier) and it increases the business assets. On the other hand it also increases the liabilities towards the supplier, which will then be referred to as the creditor.

+

Assets

=

+

Liabilities

Debit - Stock Account = Credit - Creditor’s Account

Sell services or goods:

  1. Sell services for cash:

    The business receives an asset (cash) from another party (the customer) and it increases the business assets. On the other hand it also increases the nominal accounts (income).

    +

    Assets

    =

    +

    Income

    Debit - Bank Account = Credit - Sales Account

  2. Sell services on credit:

    The business receives an asset (debtor) from another party (the customer) and it increases the business assets. On the other hand it also increases the nominal accounts (income).

    +

    Assets

    =

    +

    Income

    Debit - Debtor’s Account = Credit - Sales Account

  3. Sell stock for cash:

    The business gains an asset (cash) from another party (the customer) and it increases the business assets. On the other hand it also increases the nominal accounts (income).

    The business loses an asset (stock at cost price) and it decreases the business assets. On the other hand it also decreases the nominal accounts (cost of sales).

    +

    Assets

    =

    +

    Income

    -

    Assets

    =

    -

    Cost of sales

    Debit - Bank Account = Credit - Sales Account with the Selling Price of the goods sold.

    Debit - Cost of Sales Account = Credit - Stock Account with the Cost Price of the goods sold.

  4. Sell stock on credit:

    The business gains an asset (debtor) from another party (the customer) and it increases the business assets. On the other hand it also increases the nominal accounts (income). The business loses an asset (stock at cost price) and it decreases the business assets. On the other hand it also decreases the nominal accounts (cost of sales).

    +

    Assets

    =

    +

    Income

    -

    Assets

    =

    -

    Cost of sales

    Debit - Debtor’s Account = Credit - Sales Account with the Selling Price of the goods sold.

    Debit - Cost of Sales Account = Credit - Stock Account with the Cost Price of the goods sold.

Receive cash from debtors:

The business gains an asset (cash) from another party (the customer) and it increases the business assets. On the other hand it also decreases the business assets (debtors).

+

Assets

=

-

Assets

Debit - Bank Account = Credit - Debtor’s Account

Payment of creditors:

The business decreases a liability (creditor) with the money paid to the other party (the creditor) and it decreases the business assets (cash).

-

Assets

=

-

Liabilities

Debit - Creditor’s Account = Credit - Bank Account

In addition to these transactions, you may also find other transactions, such as

  1. Returns to suppliers, which has the opposite affect on the accounting equation as purchases.

  2. Credit notes or goods returned, received from customers has exactly the opposite effect on the accounting equation as sales.

  3. Correction of errors and adjustments, which does not necessarily involve a third party.

 

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